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UK inflation down. AAA rating under threat

Inflation has fallen to 3.6%. But it's not all moonlight and roses in Whitehall this Valentine's Day: Moody's has put the UK rating on 'negative outlook'.

by Rebecca Burn-Callander

Published: 14 Feb 2012

Last Updated: 19 Aug 2013

The latest Consumer Prices Index (CPI) shows that inflation has dropped from 4.2% in December to just 3.6%, a 14-month low. The sharp drop is down, in part, to lower fuel prices and cheaper restaurant nosh. The effects of the VAT increase in January 2011 (from 17.5% to 20%) are also finally fading: consumers have adjusted to the sudden price hikes on goods.

The air is steadily seeping out of the inflation balloon. The UK could even hit the target 2% rate by the end of the year, according to the Bank of England. The Retail Prices Index, which measures the cost of everything from retail goods to mortgage repayments, has also dropped: from 4.8% to 3.9%. But elsewhere in the UK economy, there’s a whiff of danger. The eurozone crisis is yet to be resolved. The UK’s economic growth is stunted. Unemployment is rising. Unsurprisingly, thus, Moody’s is taking a closer look at our triple A.

It’s not a downgrade, it’s not even a bona fide warning. It’s more of a stiff talking to. Our austerity measures aren’t working fast enough, says the ratings agency. The UK government still holds over a trillion pounds of debt and is vulnerable to further shocks from the eurozone. As Moody’s put it: ‘Any further abrupt economic or fiscal deterioration would put into question the government's ability to place the debt burden on a downward trajectory by fiscal year 2015-16.’

What does it all mean? A ‘negative outlook’ gives the UK a 30% chance of losing its shiny AAA rating. It also means that borrowing costs might rise – a blow to Chancellor George Osborne who’s been dining out on our 2% interest rate for months. Long-term, however, this label is fairly benign. The markets have barely blinked: the yield on 10-year UK government bonds edged up by a single percentage point to 2.13% this morning. Even a downgrade isn’t the end of the world. Just look at the US: it lost its triple A last year and is still seen as a safe haven for investment.

The UK isn’t the only country to find itself on the ‘negative outlook’ pile. Austria and France are keeping us company. Italy, Malta, Portugal, Slovakia, Slovenia and Spain have fared less well, with full on downgrades.

‘This is a reality check for anyone who thinks Britain can duck confronting its debts,’ concludes Osborne. But he better ready himself for a battle. The Opposition has another explanation for the ‘negative outlook’: ‘Unless you have growth, if your plan is unbalanced it becomes self-defeating,’ says Shadow Chancellor Ed Balls. ‘Even the ratings agencies are waking up to the fact George Osborne's plan is not working.’

Nice shot, Ed. That’s both Moody’s and Osborne lambasted in one fell swoop.